The needs approach is a method that calculates the required life insurance needed by an individual or family to cover their needs. It basically answers how much will be needed to meet obligations at the time of death as well as the needed future income by the survivors to keep up the household. In the case of the Wright family, their total annual need is equivalent to $48,600.
This value was determined by: 1. ) calculating seventy-five percent of the present combined take-home pay of Sue and Tom Wright which is $80,000 per year; 2.) subtracting the take-home pay of the surviving spouse (Tom), which is $40,000, to determine the income gap; 3. ) adding the $600 annual child care expenses to the income gap then subtracting the annual child support benefit of $12,000 to the total expenses to get the net gap; and, 5. ) adding to the net gap the take-home pay of Tom Wright.
Thus: 75% of $80,000 = $60,000 – $40,000 = $20,000 income gap; $20,000 + $600 – $12,000 = $8,600 net gap; $40,000 + $8,600 = $48,600 total annual need The $48,600 would represent a stream of cash flows of which the present value is the amount that needs to be in the Family Maintenance Fund.
The inflation rate is 3%, used as r and the number of year as t in the formula for present value interest factor (PVIF).
Assuming that Mike (aged 13) and Karen Wright (aged 11) will be dependent until they are eighteen, the number of years Tom Wright will need $48,600 is calculated by subtracting the age of the youngest child from 18, thus 18-11=7. This means that Tom Wright will basically need this amount for seven years.
In order to calculate the total present value of the cash flow for seven years, the present value for each year has to be solved first.
This is done by multiplying $48,600 to the PVIF for each year. The formula for the PVIF is 1/(1 + r)t where r is the inflation rate and t is the year (1 = 1st year, 2=2nd year, and so on until t=7). A Life Insurance Protection Gap of $50,000 means that they have an insurance for $252,791. 75 ($302,791. 75 – $50,000). This gap could be closed by any of the following: 1) They can contact insurance companies for an affordable term life insurance. Once they fill out a form, they would be provided a rate information from insurance agents.
Insurance agents usually come from a large number of life insurance firms and they can give their client contact information for many companies where the client has the freedom to choose the rate he likes better. 2) By going to the website www. insurance4usa. com. The website will give the client different rates to choose from. 3) By setting an appointment with their investment banker. An investment banker can help his client close the gap by presenting a variety of investment options as well as the pros and cons of each investment option.
The client has the opportunity to choose which investment option he thinks will be suited for his family.
References
Needs Approach. (n. d. ). Retrieved March 15, 2008, from Investopedia. http://www. investopedia. com/terms/n/needsapproach. asp Present Value Interest Factor (PVIF). (n. d. ). Retrieved March 15, 2008, from Investopedia. http://www. investopedia. com/terms/p/pvif. asp We Help You Find Affordable Insurance Rates. (2000-2007). Retrieved March 15, 2008, from Insurance4USA. com. http://www. insurance4usa. com
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